To Fix Or Not To Fix Your Interest Rate?
With Fixed Mortgage Rates So Low Should You Fix Your Home Loan?
Apr 25, 2009
With interest rates in Australia decreasing substantially over the past few months many people are once again asking that age old question- should they fix their interest rate? In the US, until several years ago all home loans were fixed. In New Zealand most mortgages have fixed rates.
Fixed rate mortgages provide certainty of repayments over a set period. In the US the rate is fixed for the full term of the loan, often 30 years, meaning there is a reduced likelihood of clients getting into trouble with repayments. Unfortunately several years ago the US market introduced a new product, the adjustable rate mortgage (ARM), and those involved did not fully understand (or simply chose not to understand) the implications.
Over the past 50 years in Australia the average bank variable interest rate was 8.87%. From January 1993 through to the middle of 2008, three year fixed rates were above the bank standard variable rate for 9 of those 15 years (source: Australian Bank Home Loan Interest Rate History. (Ability Finance. March 31, 2008). However, until recently the local bank manager easily discounted a client's rate by between 0.4 and 0.7%, therefore the fixed rate has nearly always been higher.
So, case solved? Well, not quite.
Cheapest Rate In 50 Years?
Most people fix their interest rate because they want certainty with their budget. By fixing their mortgage for three years (or more) they can be certain of what their repayments will be and can plan accordingly. They pay extra for this peace of mind, but for some it is worthwhile. With some experts predicting interest rates will soon be the lowest in fifty years, decreasing to a cash rate of around 2%, it will be extremely tempting to fix mortgage rates.
With a fixed rate, the average term of which is three years, if a client wants to refinance to take advantage of a lower variable rate (and going by the statistics mentioned above this is very likely to be the case) they have to pay extra fees, fees that are not applicable to variable rate loans. According to Cannex the average early termination fee on a fixed-rate loan is $1,483, with fees as high as $5,685. Non-bank lenders tend to charge higher exit fees than the major banks.
The average fixed rate loan charges a break cost if it is paid it out early. Many people currently on high fixed rates are now finding this out, much to their dismay. The break cost varies according to the time remaining on the fixed term, meaning the longer the time remaining the higher the fee.
This cost is calculated by multiplying the difference between the current lower variable interest rate by the outstanding loan balance, which in turn is multiplied by the years remaining in the fixed term of your current loan (Fixed Rate Mortgage Exit Fees. Smart Search Mortgages. February 8, 2009.). A client can easily find themselves with a break cost fee totalling many thousands of dollars.
Sticking to variable rate mortgages will save money over the term of the loan, but be prepared for times such as last year when rates went up significantly. So before a client signs up for a fixed rate, they must study all the costs and exit fees involved.
Investment Loans
A final consideration applies to investment loans. With rates declining many property investors are at last seeing the gap closing between the cost of their property and the rent they receive. At some point they will even see a small positive cash-flow each month. The pressure to then fix their interest rate will be intense, especially if they can fix for five years at a rate that provides them with positive cash-flow over that entire period of time.
In the end it is a choice that should be made depending upon each client's circumstances.
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